DP7866 Foreign Entry and Spillovers with Technological Incompatibilities in the Supply Chain

Author(s): Juan Carluccio, Thibault Fally
Publication Date: June 2010
Keyword(s): host country welfare, multinational firms, pecuniary externalities, technological incompatibilities
JEL(s): F23, O14
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7866

Does foreign entry improve host country productivity and welfare? Existing studies have focused on the role of technology spillovers and backward linkages with domestic suppliers. In this paper, we study how these externalities are affected by technological incompatibilities between foreign and domestic technologies. When foreign technologies require specialized inputs, some local suppliers self-select into production for multinational firms. A decrease in the cost of inputs compatible with the foreign technology has heterogeneous effects. It benefits foreign firms and the most productive downstream domestic firms adopting the foreign technology, and negatively affects firms using the domestic technology. The impact on welfare is positive when we allow for endogenous entry in both upstream and downstream industries, but welfare gains can be negatively related to observed foreign presence at equilibrium. Our model can also reproduce various stylized facts drawn from the empirical literature on vertical and horizontal FDI spillovers.